Definition, Function, Type, and Example of Profitability Ratios

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Business, Empire, Money, Man, Suit

Financial ratios are tools used by company management in assessing the effectiveness of company performance in one period. Financial ratios are also used as an evaluation tool to further enhance the company’s subsequent performance. Basically, financial ratios consist of four parts, namely financial liquidity ratios, activity ratios, solvency ratios, and profitability ratios. In this article, we will discuss more about profitability ratios.

Profitability Ratio is a ratio or ratio to find out the company’s ability to get profit from earnings (earnings) related to sales, assets, and equity based on a certain measurement basis. Types of profitability ratios are used to show how much profit or profit derived from the performance of a company that affects the records of financial statements that must be in accordance with financial accounting standards.

Profitability Ratio Function

Profitability ratios needed to record financial transactions are usually assessed by investors and creditors (banks) to assess the amount of investment profits to be obtained by investors and the amount of corporate profits to assess the company’s ability to pay debts to creditors based on the level of use of assets and other resources so that it looks company efficiency level.

The effectiveness and efficiency of management can be seen from the profits generated against the company’s sales and investments as seen from the elements of the financial statements. The higher the value of the ratio, the better the company’s condition based on profitability ratios. High value symbolizes the level of profit and high company efficiency that can be seen from the level of income and cash flow. Profitability ratios provide important information than the previous period’s ratios and competitor achievement ratios.

Thus, an analysis of industry trends is needed to draw useful conclusions about a company’s profitability. Profitability ratios reveal the final results of all financial policies and operational decisions made by the management of a company in which the petty cash recording system is also influential.

Types of Profitability Ratios

Profitability ratios are divided into seven types, namely gross margin (GPM), profit margin ratio (PMR), net profit margin (NPM), operating ratio (OR), earning power of total investment (EPTI), return of investment (ROI), profitability own capital (RMS). Several types of profitability ratios that are often used to review a company’s ability to generate profits that are used in types of financial accounting include:

a. Gross Profit Margin
Gross profit margin is the ratio of profitability to assess the percentage of gross profit to revenue generated from sales. Gross profit affected by the cash flow statement describes the amount of profit obtained by the company with consideration of the costs used to produce products or services.

This Gross Profit Margin is often referred to as the Gross Margin Ratio. Gross profit margin measures the efficiency of calculation of cost of goods or production costs. The greater the gross profit margin, the better (efficient) the company’s operational activities which show the cost of goods sold is lower than sales (sales) which is useful for operational audits. If on the contrary, the company is not good in conducting operational activities.

Gross Profit Margin = (gross profit / total income) x 100%
Example:

PT Megah Sejahtera’s gross profit: Rp.48,000,000

Total company revenue: IDR 55,000,000

Then the Gross Profit Margin of the company PT Megah Sejahtera = (Gross Profit: Total Revenue) x 100%

= (48,000,000: 55,000,000) x 100%

= 87%

b. Net Profit Margin
Net profit margin is a profitability ratio to assess the percentage of net profit earned after deducting taxes from the income derived from sales. This net profit margin is also called the profit margin ratio. This ratio measures net income after tax against sales. The higher the net profit margin the better the operation of a company. Net profit margin is calculated using the following formula.

Example:

Net Sales Revenue = Rp27,063,310,000,000.

Net Profit after Tax (Net Profit after Tax) = Rp2,064,650,000,000.

Net Profit Margin: ??

Answer:

Net Profit Margin = Net Profit after Tax: Net Sales Revenue

Net Profit Margin = Rp2,064,650,000,000: Rp27,063,310,000,000

Net Profit Margin = 7.63%

c. Return on Assets Ratio

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